In a new issue brief, Broadening the Tax Base and Raising Top Rates Are Complements, Not Substitutes, EPI Federal Budget Policy Analyst and Century Foundation Fellow Andrew Fieldhouse argues that the Tax Reform Act of 1986 is a flawed template for contemporary reforms. Contrary to the popular mantra of “broadening the base and lowering rates,” policymakers should actually raise top rates while broadening the base to increase revenues and restore progressivity to the tax code.
“Despite Washington’s fixation with 1986-style tax reform, there is no budgetary or economic case for lowering top tax rates, which are already far below revenue-maximizing levels,” said Fieldhouse. “The United States does not need and cannot afford a repeat of 1986-style tax reform. We need reform that raises adequate revenue, makes the tax code more progressive, and treats raising top marginal tax rates and broadening the tax base as complements, not substitutes.”
The Tax Reform Act of 1986 was intended to be revenue and distributionally neutral, but these objectives are no longer viable in the context of sharply rising income inequality and the aftermath of the Bush-era tax cuts. While many believe that low top tax rates spur growth, it is increasingly clear that the economic benefits of tax cuts for the wealthy are negligible. Raising the current top marginal tax rate would make the tax code more progressive and bring in much needed revenue, without unduly reducing productive economic activity.
Meanwhile, higher top tax rates are actually complemented by base-broadening reforms. Closing loopholes and eliminating preferences for investment income would decrease opportunities for tax avoidance and reduce overall behavioral responses to rate increases, thereby increasing the revenue maximizing tax rate. In fact, best estimates of behavioral responses to the tax code suggest the top statutory federal income tax rate could be raised as much as 26 percentage points before reaching revenue maximization, and perhaps another 10 percentage points higher in a broader tax code with fewer avoidance opportunities.